Chapter 07 – How to Obtain the Right Financing for Your Business
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CHAPTER
How to Obtain the Right
Financing for Your Business
CHAPTER CONTENTS
Learning Objectives 7.2
Chapter Overview 7.2
Brief Chapter Outline 7.2
7
Chapter 07 – How to Obtain the Right Financing for Your Business
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LEARNING OBJECTIVES
After studying the material in this chapter, the student will be able to:
1. Explain the importance of proper financing for a small business.
2. Tell how to estimate financial needs, and explain some principles to follow in obtaining fi-
nancing.
CHAPTER OVERVIEW
Chapter Seven covers the phrase: Sufficient capital is essential not only for small business
startups but also for their continued operation. In the text on page 181, it tells you, “One main reason for
the high failure rate of small businesses is inadequate or improper financing.” This chapter is an im-
BRIEF CHAPTER OUTLINE
I. ESTIMATING FINANCIAL NEEDS
A. Principles to Follow
B. Using Cash Budgets
II. REASONS FOR USING EQUITY AND DEBT FINANCING
III. TYPES OF DEBT AND EQUITY SECURITIES
A. Equity Securities
B. Debt Securities
IV. SOURCES OF EQUITY FINANCING
A. Self
Chapter 07 – How to Obtain the Right Financing for Your Business
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V. SOURCES OF DEBT FINANCING
A. Trade Credit
VI. WHAT LENDERS LOOK FOR
Chapter 07 – How to Obtain the Right Financing for Your Business
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CHAPTER OUTLINE AND TEACHING NOTES
CHAPTER OPENING PROFILE:
Meet Sarah Coxwell of Davis Coxwell & Co LLC
Sarah Coxwell worked part-time for a health food store while in college, and after gradua-
I. ESTIMATING FINANCIAL NEEDS
Learning Objective 1.
Explain the importance of proper financing for a small
business.
A. Sufficient capital is essential not only
small businesses.
Objective 2.
Tell how to estimate financial needs, and explain some
principles to follow in obtaining financing.
C. As a general rule, small businesses’ long-
lived assets, such as buildings and other
D. The SBA suggests that you consider
the following:
1. Determine seed money needed to
startup.
2. Determine which costs are one-time
Chapter 07 – How to Obtain the Right Financing for Your Business
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CHAPTER OUTLINE AND TEACHING NOTES
costs.
3. Determine ongoing costs.
4. Separate your costs into fixed
E. Principles to Follow
1. FIXED ASSETS are those that are of
a relatively permanent nature and are
necessary for the functioning of the
business.
a. Fixed assets should be financed
2. WORKING CAPITAL is current as-
sets less current liabilities, that a firm
uses to produce goods and services,
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CHAPTER OUTLINE AND TEACHING NOTES
counts receivable, and inventory.
3. Management of working capital is
Important because:
a. Business may be undercapital –
F. Using Cash Budgets
1. CASH BUDGETS project working
capital needs by estimating what out-
2. In most businesses, revenue varies
from one period to another, while
costs tend to be constant.
3. When sales are made on credit, the
II. REASONS FOR USING EQUITY AND DEBT
FINANCING
Learning Objective 3.
Explain why equity and debt financing are used, and de-
scribe the role each plays in the capital structure of a small firm.
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CHAPTER OUTLINE AND TEACHING NOTES
A. EQUITY is an owner’s share of the assets
of a company. In a corporation, it is repre-
sented by shares of common or preferred
stock.
1. For proprietors and partners, equity
is the same as the owner’s personal
assets.
4. COMMON STOCKHOLDERS are the
owners of a corporation with claim to
5. PREFERRED STOCKHOLDERS are
owners with a superior claim to a
share of the firm’s profits, but they of-
ten have no voting rights.
5. DEBT FINANCING comes from lend-
B. Role of Equity Financing
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CHAPTER OUTLINE AND TEACHING NOTES
1. Equity financing serves as a buffer
C. Role of Debt Financing
1. With debt financing, the principal and
interest payments:
2. Reasons for using debt financing
a. The cost of interest on debt is
usually lower than on equity, and
3. FINANCIAL LEVERAGE is using
fixed-charge financing, usually debt,
to fund a business’ operation.
4. Another type of debt financing is
5. A LEASE is a contract that permits
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CHAPTER OUTLINE AND TEACHING NOTES
6. The benefits of a lease are:
a. The payments are tax deductible.
REAL WORLD EXAMPLE 7.1
Ryder Commercial Leasing and Services handles the en-
tire distribution function for customers.
III. TYPES OF DEBT AND EQUITY SECURI-
TIES
Learning Objective 4.
Distinguish the types of equity and debt securities.
A. Equity Securities
1. COMMON STOCK, representing the
owners’ interest, usually consists of
many identical shares, each of which
2. PREFERRED STOCK has a fixed
par value and a fixed dividend pay-
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CHAPTER OUTLINE AND TEACHING NOTES
3. SMALL COMPANY OFFERING
REGISTRATION (SCOR) is the sale
of common stock to the public
through a regulated board such as
Nasdaq or AMEX without the hassle
of an initial public offering.
a. This is a uniform registration that
B. Debt Securities
1. Debt securities usually in the form of
2. Small companies rely more on pri-
vate loans from financial institutions.
3. Securities are classified by time
frame.
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CHAPTER OUTLINE AND TEACHING NOTES
c. LONG-TERM SECURITIES ma-
ture after five years or longer.
4. For a small business owner negotiat-
5. BONDS are a form of debt security
6. A MORTGAGE LOAN is long-term
debt secured by real property.
7. A CHATTEL MORTGAGE LOAN is
8. ASSET-BASED FINANCING accepts
as collateral the assets of a firm in
exchange for the loan.
9. “Unsecured” loans from banks to
IV. SOURCES OF EQUITY FINANCING
Learning Objective 5.
Describe some sources of equity financing.
A. Obtaining sufficient equity funding is a
constant challenge for small businesses.
1. The only way for proprietors or part-
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CHAPTER OUTLINE AND TEACHING NOTES
2. Corporations have more choices,
such as selling stock or bonds.
B. Self
1. Small business owners rely more on
their own capital and less on external
debt capital than owners of larger
firms.
4. Outside investors want reassurance
that the owner is committed to the
business’ success.
5. Many owners prefer using their own
funds.
6. For the smallest firms, owner capital
is the most important source of fi-
nancing.
C. Small Business Investment Companies
(SBICs)
1. SMALL BUSINESS INVESTMENT
COMPANIES (SBICs) are private
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CHAPTER OUTLINE AND TEACHING NOTES
2. SBICs are intended to be profit–mak-
D. Venture Capitalists
1. VENTURE CAPITAL (VC) FIRMS
make investments based on pro-
jected future income and generally
3. Venture capitalists prefer to invest in
high-growth industries.
4. Some venture capitalists adopt a
more traditional relationship with
5. Many venture capitalists rely heavily
on the executive summary of a busi-
ness plan when making investment
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CHAPTER OUTLINE AND TEACHING NOTES
6. Venture capitalists also provide man-
agement skills and business con-
tacts.
7. A potential conflict between the new
business owner and the venture capi-
E. Angel Capitalists
1. ANGEL CAPITALISTS, or BUSI-
NESS ANGELS, are wealthy local
business people and other investors
who may be external sources of eq-
uity funding.
F. Other Sources
REAL WORLD EXAMPLE 7.2
Lucy Valena’s expresso catering service received a
$4,000 microloan, after her SBA advisor recommended she
seek funds from Samuel Adams Brewing, the American
Dream program.
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CHAPTER OUTLINE AND TEACHING NOTES
A non-profit organization, KIVA.com, is a loan distribu-
tor through small financial institutions, who raises funds for
world-wide projects.
1. Business incubators nurture young
firms and help them to survive and
grow during the vulnerable start up
2. EMPLOYEE STOCK OWNERSHIP
PLANS (ESOPs) allow small busi-
nesses reap tax advantages and
cash flow advantages by selling stock
shares to workers.
3. Another source of equity funding is
your customers, by:
a. Requiring the customer to pay
REAL WORLD EXAMPLE 7.3
Diane Allen, a portrait artist, requires a down payment of
one-third of the total price before she starts a portrait.
4. BARTER consists of two or more
companies exchanging items of
roughly equal value.
a. This business practice has be-
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CHAPTER OUTLINE AND TEACHING NOTES
b. Bartering can be used for busi-
ness travel, debt collection, clos–
ing a sale, employee perks, and
as a line of credit.
5. Bartering Rules:
a. If items are dissimilar-a truck for
a desk, for example-record the
new asset at its document fair
V. SOURCES OF DEBT FINANCING
Learning Objective 6.
Describe some sources of debt financing.
A. Most small business owners rely more on
owner funding than debt financing.